I resigned from a job and started a business. I took R300 000 of my pension out as an emergency fund and left the remainder in a preservation fund. I am currently earning enough and have no need to dig into the R300 000. I have a bond of roughly R1 million that I am paying off and vehicle finance of about R280 000. I have put the R300 000 into the home loan account and I still pay the bond and vehicle from my salary on a monthly basis at the amount I was paying before the interest rate decreased. The interest on the bond is prime plus 0.25%. Is it advisable to keep the money in the bond or are there better investments that I could make considering my current situation?
Congratulations on starting your own business.
What to do depends where you are financially in terms of your retirement saving and other goals. Since I do not have enough information about you, my response is limited to the following.
Depending on how long you have to go until retirement and whether or not you have saved enough for retirement I would suggest that you put this money back to work for the purpose of providing for your golden years. What we know is that only 6% of South Africans can afford to retire without having to depend on other sources of financial support.
You may choose to invest the money in a retirement annuity since you are currently not contributing to a retirement fund. This will be very tax-efficient in terms of what you can claim in your tax return as well as the growth on the investment portfolio. You will not be taxed on the growth in this investment structure, which is not the case with a unit trust, cash, or shares in discretionary investments.
Example of retirement annuity deduction on retirement contributions:
- Let’s say you earn R750 000 per year: you would qualify for a deduction on a R206 250 (R750 000 x 27.5%) contribution into a retirement annuity fund for the year.
- At the current tax rate, you would qualify for a refund of R84 562.50 from the South African Revenue Service (Sars).
- This means you would save R84 562.50 in tax in the current tax year, meaning that you would be ‘out of pocket’ by only R121 687.50 (R206 750 – R84 562.50).
If you prefer to have access to the funds, you can look at unit trust investments or choose from the many other discretionary options available.
Be sure to check the terms of the investment so you can avoid being locked in for five years and then having to pay penalties for accessing the funds.
When you look at the growth aspect of the various investment options, you need to consider how long you plan to invest for. If this investment is for the shorter term, then taking on risk in an equity investment is not advisable. Bear in mind that keeping your money in cash erodes the buying power over time as the growth will not keep up with inflation. Depending on what your shopping basket looks like, your inflation rate will most probably be higher than the government’s inflation band.
You mention that your bond rate is 0.25% over prime, which is currently 7%; that makes the interest rate 7.25%. By putting your money into the home loan account, you’re effectively earning a 7.25% return on your investment (at very little risk). Furthermore, if it’s a flexible home loan, you can withdraw funds when you need them (say if the business needs emergency cash/liquidity).
The smart thing to do is to speak to a certified financial advisor who will look at your current situation and advise the most appropriate course of action for your needs.